November 2nd – Lifeline

What I’m Reading

One Big Thing: A couple of weeks ago, I wrote about how ESG trends are likely to provide a growing headwind for the office market in the coming years.  Today, I’m going to focus on a different segment of the real estate market that I’ve followed closely for years: housing.

It’s no secret that housing has been a darling of the pandemic economy.  Sales are booming – especially in the suburbs, inventory is as tight as ever and prices are spiking.  However, there are dark clouds on the horizon in 2021: expiring forbearances.  Bloomberg’s Michael R. Strain pointed this out in an opinion piece last week (emphasis mine):

A wave of foreclosures is likely coming that will hit low-income homeowners. As of August, over 10% of the eight million single-family mortgages backed by the Federal Housing Administration were delinquent by more than three months.

According to the FHA, the reason for 86% of those delinquencies was “a national emergency,” a category that includes the pandemic. These delinquencies are heavily concentrated among loans associated with low credit scores.

At the same time, the FHA reports that foreclosures have ground to a halt. In August, 352 foreclosures were started, compared with 10,438 in February.

An important explanation for why there are so few foreclosures amid so many delinquencies can be found in the Cares Act, the economic recovery law passed in March. It included forbearance provisions that allowed borrowers with government-backed mortgages to postpone (or reduce) payments for up to 12 months if they suffered Covid-related financial hardship.

When these forbearance provisions expire in 2021, expect a wave of foreclosures to follow.

Indeed, things are not looking great outside of the FHA-backed world either.  Black Knight reported that more than 2.3 million homeowners – five times the number entering 2020 – remain 90 or more days past due, but not in foreclosure.

If we look back to the 2008 playbook, there is a lot of reason for concern here.  Once forbearance wears off, borrowers will need to make arrangements to restart mortgage payments, including amortizing the deferred interest over the previous 12 months.  That may work fine if those borrowers become gainfully employed again but not so much if they are jobless.

That being said, there is something that the Bloomberg commentary above is missing – the housing market in 2020 looks absolutely nothing like 2008. For one, supply has been tight for years, with starts never making it anywhere close to their previous peak, despite a larger population.  This is especially true at the entry level.

https://fred.stlouisfed.org/graph/graph-landing.php?g=wVmO&width=670&height=475

Another major factor that is different from 2008 is that the mortgage market has gone though a long stretch of stability and conservative underwriting.  Many would argue that lending conditions have been too tight, whereas no sane person would have made that argument in 2005.  As a result, it has been more difficult to get a loan, typically requiring more money down (more equity), to go along with higher credit scores.  Between tight mortgage credit and reduced housing supply, the amount of equity that Americans have in their homes in 2020 far exceeds 2005, the previous peak.  

https://fred.stlouisfed.org/graph/graph-landing.php?g=x6DX&width=670&height=475

A borrower who is financially distressed and underwater (2008 scenario) has little choice but to face foreclosure.  A borrower who is financially distressed but has a substantial amount of equity in their home has options – the primary one being to sell the home at a profit and move into a less expensive living situation.  However, that move entails uprooting one’s family which is one of many reasons that borrowers tend to drag things out to the 11th hour.

What I suspect will actually happen is a boom in residential sale-leasebacks where large investors that have become starved for new inventory in recent years will begin to target borrowers in expiring forbearance plans with offers to buy their homes and lease them back for a period of time. In fact, several of the big players in the space are already making plans to make this a major focus of their business plan going forward.  Post Great Recession, large investors made their mark buying homes at the courthouse steps.  Post pandemic, they will focus more on buying direct from distressed sellers.

In the short term, this will be a win for both the investor and the seller.  The investors will get grow their AUM without leasing risk.  The sellers will get their equity out, allowing them to pay living expenses without having to uproot their lives.  However, there are also long term risks, primarily a further loss of entry level housing stock to the rental market.  Historically, purchasing an entry level home is the pathways to a middle class lifestyle.  This has become more difficult in recent years as much of the entry level inventory was bought up by investors during the Great Recession and rising construction and land costs have made it difficult for builders to deliver new units in desirable areas that are also affordable.  Unfortunately, the market dynamics that will likely allow us to subvert a foreclosure crisis will sew the seeds of a future affordability crisis.  

Shortfall: The pandemic induced recession has US states facing the biggest cash crisis since the Great Depression.  The drop in tax revenue has led to a total shortfall expected in the hundreds of billions of dollars—greater than 2019’s K-12 education budget for every state combined, or more than twice the amount spent that year on state roads and other transportation infrastructure. 

The resolution of this budget crunch largely hinges on the election.  If Biden prevails, I would expect to see more aid.  If Trump wins, expect less aid considering that he is on the record that he doesn’t want Covid-19 aid used to address longstanding financial problems.  Wall Street Journal

Guinea Pigs: Walmart is turning four of its stores into laboratories that test ways to turn the company’s huge physical footprint into a more powerful edge for e-commerce.  Walmart’s biggest advantage over Amazon is that they have massive retail footprints near valuable customers, thanks to their stores.  The key is converting those brick and mortar assets into hybrid facilities to accommodate ecommerce without sacrificing their traditional business.  CNBC

Metamorphosis: Amazon has purchased the former headquarters of the OC Register in Santa Ana.  It plans to raze the 120,000 sf class-A office building in order to build a last mile distribution center.  We are in the early stages of coming to grips with the fact that we have too much of certain real estate product types and not enough of others – mainly housing and warehouse.  Expect to see more of this in the future with a big caveat – it is far easier to re-develop office buildings than it is hospitality and retail because offices don’t generate sales or lodging taxes that fund city budgets.  OC Register

Coming Surge: Lenders and special servicers are running out of patience on many of the short term forbearances that they agreed to at the onset of the pandemic and workout specialists – especially those that specialize in CMBS – are getting ready for a flood of new business.  The Real Deal

Cash is Trash: With yields near zero, some publicly traded companies are getting more aggressive with their balance sheets, including taking some eye-popping risks in order to generate returns. Wall Street Journal

Bright Spot: Technology and media companies are still actively leasing office space in Los Angeles.  However, vacancy as a whole is still on the rise.  Globe Street

Chart of the Day

In the last 5 years, new homes have shifted from a historic premium over resales to a below normal premium. First, builders shifted down in size and specification level. Now, they are pushing to the distant suburbs where homes are less expensive. – John Burns 

chart, line chart

Source: JBREC

WTF

Full Experience: A leopard mauled a man who paid for a ‘full contact experience’ with the big cat because Florida.  Fox 11 Los Angeles

Respect the Hustle: A New Hampshire woman was accused of impersonating a prosecutor and dropping criminal charges against herself.  New Hampshire Union Leader

When You Gotta Go: A North Carolina pastor was arrested after being accused of urinating on a fellow passenger on a Delta Airlines flight.  Winston-Salem Journal

Basis Points – A candid look at the economy, real estate, and other things sometimes related.

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